Thomas Freidman Spews Nonsense with Hurricane Force

Sunday, 28 August 2011 12:18

Yes, it’s Sunday and Thomas Friedman has another of his whacky big picture columns:

“Now let me say that in English: the European Union is cracking up. The Arab world is cracking up. China’s growth model is under pressure and America’s credit-driven capitalist model has suffered a warning heart attack and needs a total rethink. Recasting any one of these alone would be huge. Doing all four at once — when the world has never been more interconnected — is mind-boggling. We are again ‘present at the creation’ — but of what?”

pretty profound stuff.

Okay, let’s get to specifics. We leave out the Arab world, skip China for a moment, and jump to the European Union. Friedman tells us:

“Farther north, it was a nice idea, this European Union and euro-zone: Let’s have a monetary union and a common currency but let everyone run their own fiscal policy, as long as they swear to work and save like Germans. Alas, it was too good to be true. Large government welfare programs in some European countries, without the revenue to finance them from local production, eventually led to a piling up of sovereign debt — mostly owed to European banks — and then a lender revolt. The producer-savers in northern Europe are now drawing up a new deal with the overspenders — the PIIGS: Portugal, Italy, Ireland, Greece and Spain.”

There is lots of good stuff here. First, the European Union and the euro-zone are not the same thing. There are countries with names like the United Kingdom, Denmark, and Sweden that have been longstanding members of the European Union that are not members of the euro-zone. While there have been some suggestions that heavily indebted countries consider leaving the euro, one would be hard-pressed to find anyone suggesting they leave the European Union.

This is not the only complete invention in Friedman’s story. The story of the heavily indebted countries as serious overspenders spits in the face of reality. Spain and Ireland were actually running budget surpluses in the years preceding the recession. Italy and Portugal had relatively modest deficits. Only Greece had a clearly unsustainable budget path.

The story of the debt crisis of these countries is primarily the story of the inept monetary and financial policy run by the European Central Bank (ECB) in the years leading up to the crisis. They opted to ignore the imbalances created by housing bubbles across much of the euro zone and the rest of the world. Rather than taking steps to rein in these bubbles, they patted themselves on the back for hitting their 2.0 percent inflation targets. Remarkably, none of these central bankers lost their jobs and the 2.0 percent cult still reins at the ECB.

If there is a crisis in the euro zone it is that a dogmatic cult has seized control of the euro zone monetary and financial policy to the enormous detriment of its economy and its people. And, there is no obvious mechanism through which they can be dislodged. Friedman might have devoted his column to this problem, but it requires far more knowledge of the economy than he seems to possess.

Now let’s get to the China and U.S. problem that Freidman discusses. Friedman tells us that:

“China’s growth model is under pressure and America’s credit-driven capitalist model has suffered a warning heart attack and needs a total rethink.” To a large extent these are actually the same issue.

The United States has been running large trade deficits ever since the Rubin-Greenspan-Summers clique used their control of the IMF to impose draconian bailout terms on the East Asian countries following the East Asian financial crisis. The result of this action was that countries throughout the developing world began accumulating dollars like crazy in order to protect themselves against ever being in the same circumstances.

Their effort to acquire dollars led to the over-valued dollar (Robert Rubin’s “strong dollar”), which in turn gave us our large trade deficits. Large trade deficits logically imply either large budget deficits or large private sector savings. This fact is well-known to people who know national income accounting, which unfortunately is a tiny minority of those who write about economic issues for major media outlets.

China is one of the countries that has been accumulating massive reserves. If it desires to slow its growth rate (no one other Friedman would call going from 10 percent growth to 7 or 8 percent a crisis), the most obvious mechanism is to raise the value of its currency against the dollar. This will reduce its exports to the U.S. and increase its imports from the United States. That will help boost growth in the United States and reduce its indebtedness. In short, Friedman’s two problems here are in fact one problem with a simple solution.

Finally, Friedman shows a stunning ignorance of arithmetic when he tells readers:

“China also has to get rich before it gets old. It has to move from two parents saving for one kid, to one kid paying for the retirement of two parents. To do that, it has to move from an assembly-copying-manufacturing economy to a knowledge-services-innovation economy. This requires more freedom and rule of law, and you can already see mounting demands for it. Something has to give there.”

Using somewhat more realistic numbers (China is not seeing its population cut in half), let’s say that it is moving from having 5 workers per retiree to 2 workers per retiree over 30 years, a far faster decline than it is actually seeing. China’s output per worker has been increasing a rate of more than 8 percent a year. This means that over a 30 year period, output per worker will increase more than 10 fold.

Suppose our 5 workers are taxed at a 12 percent rate at the start of the period to give retirees an income equal to 70 percent of the typical worker’s after tax income. If we want to maintain this 70 percent ratio, when 2 workers support each retiree, it would take a tax rate of just under 24 percent to maintain this ratio.

Okay, so output per worker has increased by 1000 percent. We have to increase the tax rate from 12 percent to 24 percent. This means that with the higher worker to retiree ratio, the average worker will have a bit less than 9 times the after-tax income (76% of 1000 percent, as opposed to 88 percent of 100 percent) of her predecessor thirty years earlier who only had to support one-fifth of a retiree. If there is a problem here, it is very hard to see it.

So there we have it, Thomas Friedman once again letting his poor grasp of economics and arithmetic invent grand problems where there are none. What would be do without him?